Title: Efficiency and total factor productivity change of Malaysian commercial banks
Abstract: Abstract This paper analyses the efficiency of Malaysian commercial banks between 1996 and 2002 and finds that while the East Asian financial crisis caused a short-term increase in efficiency in 1998 primarily due to cost-cutting, increases in non-performing loans after the crisis caused a more sustained decline in bank efficiency. It is also found that mergers, fully Islamic banks, and conventional banks operating Islamic banking windows are all associated with lower efficiency. The paper estimates suggest mild decreasing returns to scale, and an average productivity change of 2.37% that is primarily attributable to technical change, which has nonetheless declined over time. Finally, while Islamic banks have been moderately successful in developing new products and technologies, the results suggest that the potential for Islamic banks to overcome their relative inefficiency is limited. Keywords: Malaysian bankingbank efficiencybank productivityIslamic banking Notes Any gambling or game of chance, which has something valuable (money and/or material goods) at stake. However, a game with nothing is really at risk for any participants are permissible. Under the Islamic Bank Act (1983), an Islamic bank is allowed to operate based on equity participation such as musharaka (partnership), which is similar to the activity of merchant banks and debt-like financing such as murabaha (sale at cost plus margin of profit) and ijarah (leasing), which are similar to the activities of commercial banks. Foreign banks also have minority shares in some local banking institutions (Detragiache & Gupta, 2006 Detragiache, E. and Gupta, P. 2006. Foreign banks in emerging market crises: Evidence from Malaysia. Journal of Financial Stability, 2(3): 217–242. [Crossref] , [Google Scholar]). Danaharta which has unwound in 2005 was set-up to purchase NPLs from banking institution over 1998–2001 to ensure that NPLs of the banking system are under control and to reduce the burden of banking institutions in managing NPLs (Central Bank of Malaysia, 1999 Central Bank of Malaysia. 1999. Annual report, Kuala Lumpur: Author. [Google Scholar]). CDRC is a facilitator in bringing creditors and debtors to the negotiating table in sorting out an agreeable and workable loan restructuring exercise. Some cases have been transferred to Danaharta. For certain industries, besides financial restructuring, CDRC also facilitates corporate restructuring such as changing the management of the companies and the sale of the non-core assets of borrower (Ariff et al., 2001 Ariff, M., Setapa, A. and Lin, E. Y.S. 2001. "Governance re-invented: Progress, constraints, and remaining agenda in bank and corporate restructuring in Malaysia". In Governance re-invented: The progress, constraints, and remaining agenda in bank and corporate restructuring in East and South-East Asia Retrieved August 17, 2005, from http://www.unescap.org/drpad/publication/toc/fin_2148con.htm [Google Scholar]). It ceased operation in August 2002. In the literature, the translog function is preferred in estimating a parametric distance function because it is flexible, easy to calculate and permits the imposition of homogeneity (Fuentes, Grifell-Tatjé, & Perelman, 2001 Fuentes, H. J., Grifell-Tatjé, E. and Perelman, S. 2001. A parametric distance function approach for Malmquist productivity index estimation. Journal of Productivity Analysis, 15(2): 79–94. [Crossref], [Web of Science ®] , [Google Scholar]). Mergers 1, 2, 3 refer to mergers between Oriental Bank and EON Bank, between Chung Khiaw Bank and UOB Bank, and between the International Bank Malaysia, Sabah Bank, and Multi-Purpose Bank, respectively. Higher input requirements as reflected in higher average gross efficiency estimates for IBS banks are also observed for domestic banks, foreign banks, merged banks, and unmerged banks categories, thereby supporting this conclusion. However, the difference is marginal within the domestic bank category, which is consistent with the finding regarding the statistical insignificance of the Z 9 variable. High interest rates prevailed at the end of 1997 as the Malaysian government tried to reduce capital outflows. This contributed to a decline in credit growth from an annual average of 30–26.5% at the end of 1997 (Lindgren et al., 1999 Lindgren, C.-J., Balino, T. J.T., Enoch, C., Gulde, A.-M., Quintyn, M. and Teo, L. 1999. Financial sector crisis and restructuring: Lessons from Asia (Occasional paper, 188). Retrieved February 2, 2007, from http://www.imf.org/external/pubs/ft/op/opfinsec/op188.pdf [Google Scholar]). The relative small size of this negative output effect may also help explain why there is no statistical evidence for a systematic effect of the financial crisis by inclusion of a 1997 year dummy. Dummy variables for 1996, 1997, all post-crisis years, as well as individual dummy variables for each of the years after 1998 were tested but were found to be statistically insignificant. Interest rates, which were very high to refrain capital outflow, were reduced in the third quarter of 1998 to support the economic recovery plan. Yudistira (2004 Yudistira, D. 2004. Efficiency in Islamic banking: An empirical analysis of eighteen banks. Islamic Economic Studies, 12(1): 1–17. [Google Scholar]) found that small- and medium-sized Islamic banks in most countries have diseconomies of scale but Alshammari (2003 Alshammari, S. H. 2003. Structure-conduct-performance and efficiency in Gulf Co-operation Council, Bangor: University of Wales. [Google Scholar]) found that the bank type has no effect of economies of scale in Gulf Cooperation Council (GCC) countries. This result is similar to findings by Orea (2002 Orea, L. 2002. Parametric decomposition of a generalized Malmquist productivity index. Journal of Productivity Analysis, 18(1): 5–22. [Crossref], [Web of Science ®] , [Google Scholar]) on Spanish banks, Isik and Hassan (2003 Isik, I. and Hassan, M. K. 2003. Financial disruption and bank productivity: The 1994 experience of Turkish banks. The Quarterly Review of Economics and Finance, 43(2): 291–320. [Crossref] , [Google Scholar]) for Turkish banks, and Casu, Girardone, and Molyneux (2004 Casu, B., Girardone, C. and Molyneux, P. 2004. Productivity change in European banking: A comparison of parametric and non-parametric approaches. Journal of Banking & Finance, 28(10): 2521–2540. [Crossref], [Web of Science ®] , [Google Scholar]) on Spanish and Italian banks where technological progress is the main determinant of productivity change. Krishnasamy, Ridzwa, and Perumal (2004 Krishnasamy, G., Ridzwa, A. H. and Perumal, V. 2004. Malaysian post merger banks' productivity: Application of Malmquist productivity index. Managerial Finance, 30(4): 63–74. [Crossref] , [Google Scholar]) found productivity improvement in 10 Malaysian commercial banks was also primarily determined by TC during the 2000–2001 period. Sufian and Ibrahim (2005 Sufian, F. and Ibrahim, S. 2005. An analysis of the relevance of off-balance sheet items in explaining productivity change in post-merger bank performance: Evidence from Malaysia. Management Research News, 28(4): 74–92. [Crossref] , [Google Scholar]) reported average total productivity growth for post-merger Malaysian banks of −1.3% for the period 2001–2003. The result is consistent with Orea's (2002 Orea, L. 2002. Parametric decomposition of a generalized Malmquist productivity index. Journal of Productivity Analysis, 18(1): 5–22. [Crossref], [Web of Science ®] , [Google Scholar]) research who finds that the average rate of productivity change of merging banks is lower than non-merging banks, and Berger and Mester (2003 Berger, A. N. and Mester, L. J. 2003. Explaining the dramatic changes in performance of US banks: Technological change, deregulation, and dynamic changes in competition. Journal of Financial Intermediation, 12(1): 57–95. [Crossref], [Web of Science ®] , [Google Scholar]) who found that productivity deterioration is greater for merging banks than non-merging banks. Moderate productivity growth is found in Islamic banks for most countries (Hassan, 2005 Hassan, M. K. Paper presented at the 12th Annual Conference. Cairo. The cost, profit and x-efficiency of Islamic banks, [Google Scholar]) but productivity loss is found for Islamic banks in Sudan, Iran, and Pakistan (Hassan, 2003 Hassan, M. K. Paper presented at the International Conference on Islamic Banking: Risk Management, Regulation and Supervision. Jakarta. Cost, profit and x-efficiency of Islamic banks in Pakistan, Iran and Sudan, [Google Scholar]). This is consistent with Hassan (2003 Hassan, M. K. Paper presented at the International Conference on Islamic Banking: Risk Management, Regulation and Supervision. Jakarta. Cost, profit and x-efficiency of Islamic banks in Pakistan, Iran and Sudan, [Google Scholar], 2005 Hassan, M. K. Paper presented at the 12th Annual Conference. Cairo. The cost, profit and x-efficiency of Islamic banks, [Google Scholar]) who also found that the productivity change of Islamic banks is driven by TC.
Publication Year: 2011
Publication Date: 2011-10-01
Language: en
Type: article
Indexed In: ['crossref']
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Cited By Count: 42
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